Attacks in Mumbai Could Force Execs in U.S. to Rethink Outsourcing Plans

December 5, 2008

The fallout from the recent terrorist attacks in Mumbai, India, will most likely be felt in U.S. boardrooms, as officers and directors reassess the risks involved in running outsourcing operations in that tension-racked country.

Granted, it’s not likely many U.S. businesses will immediately cancel outsourcing contracts with Indian vendors in the wake of the attacks, which may have killed more than 300 people. India has become the preferred outsourcing destination for U.S. corporations, with American businesses sending approximately $24 billion in technology work to Indian cities such as Mumbai, Kolkata, Chennai, Hyderabad and Bangalore in 2008. All told, U.S. companies will probably ship around $36 billion in outsourcing assignments (including IT and nontech work) to India this year, says Sanjay Puri, president of the U.S. India Business Alliance.

Typically, outsourcing deals with Indian vendors cover several years. Breaking a contract could prove to be costly, and might also threaten a client’s back-office operations or supply chain.

But Indian outsourcers are undoubtedly nervous about the situation. While the attacks last month targeted hotels, public transportation, a hospital and a Jewish center, published reports in India say the nation’s IT and outsourcing sectors remain a top target of extremists.

To guard against attacks, outsourcing vendors most likely will have to beef up the already-tight security at their facilities. Vehicles attempting to enter the Tata Consultancy Services facility in Kolkata, for example, are routinely searched by armed guards and police dogs.

More stringent precautions will cost money and boost the price of outsourcing vendors’ services. Insurance rates for the vendors are sure to go up as well, further jacking up operating costs and eroding the price advantage of doing business in India.

Compensation consultant Hewitt Associates is predicting that the average Indian worker’s wages will increase 15.2 percent this year. That follows the 15.1 percent increase in 2007 and marks the fifth consecutive year of double-digit wage increases in India. Hewitt projects annual wage increases will stabilize at around 10 percent by 2012.

In fact, managers at some U.S. companies have discovered that offshoring in India is not quite the cost saver they imagined. That’s particularly true for captive offshore operations, in which the U.S. parent sets up and runs the outsourcing operation, usually employing local workers to staff much of the operation.

A TowerGroup report on offshore outsourcing of financial services businesses predicts that the erosion of India’s wage advantage and the country’s increased political risk “will lead [financial services] firms to sell off more captives, just as CitiGroup sold its Citi Global Services to TCS in the fall of 2008.”

Analysts agree that the attacks in Mumbai—which extracted a terrible human price—will add to the bill for captive offshoring. “Outsourcing is definitely going to cost companies more money now because they’re going to have to beef up their security, they’re going to have to take precautions regarding traveling and where to stay, and they’re going to have to pay their people more money to compensate for the danger,” said Don Jones, international tax partner at consulting firm BDO Seidman.

Puri noted that U.S. corporations may experience additional costs associated with managing employees after the attacks. This could include the cost of communicating clear safety procedures, paying for stricter background checks on employees and dealing with “psychological issues” stemming from the attacks.

“If something happens to some of their employees, directly or indirectly, they have some level of responsibility, whether it’s legal or moral,” he said.

U.S. companies will also spend time and money devising alternatives for their outsourcing operations in India.

“They are making sure they have contingency plans in place and making sure the provider they are using does have the appropriate policies, processes and systems in place to handle such an event were it to occur,” said Stan Lepeak, managing director of global research at business advisory firm EquaTerra. “Any good provider is going to have redundancy in multiple locations so that if something did happen, the impact to the buyer of the services would be negative.”

But many corporations are taking the issue of redundancy out of the hands of their providers.

“These are large multinational companies, so we are not seeing a one-center strategy where they are only located in India or any one place,” said Charlie Aird, a senior managing director at PricewaterhouseCoopers.

He said companies are broadening their outsourcing to better correspond to the language and cultural needs of their client base. For example, they may place the bulk of their Latin American outsourcing in Brazil or Chile and their European outsourcing in Poland or Romania. Expect to see companies protect themselves by diversifying their outsourcing operations globally.

In the meantime, they can expect to pay more in India. Jones of BDO Seidman said corporations with captive operations already have to pay executives about 20 percent more to relocate overseas. Even companies that simply source material in India will now have to increase the pay of executives who fly there to monitor those operations.

“I’ve seen people paid up to two times the salary just for the risk factor,” he said. “Nobody wants to go over there and get shot.”